We have all been following developments in oil markets with a mixture of trepidation and puzzlement. The price of crude oil has been trending downwards since mid-2014 dipping below $30 in January 2016. The oil glut amid slack oil demand is changing market dynamics and causing serious concerns amongst oil operators and oil producing nations.
If we take a close look at oil markets trends in recent years, we realise that the conditions leading up to such drastic decline in oil price have been gathering momentum for quite some time. The reasons are very clear and are down to fundamentals of supply and demand economics. Increasing levels of supply and slack demand have been weakening the outlook of global oil markets – the bearish market sentiment became even more evident by the middle of 2014 and there began the crude oil price downward spiral. Saudi Arabia’s refusal to cut crude production in the face of excess global supply was a decisive moment; breaking with the tradition of Saudi Arabia acting as the swing producer.
How can we identify the winners and the losers in the global context of low oil prices?
This is not a clear cut task because there are so many different factors and variables impacting current global oil markets. To a certain extent all oil producers are losers when we analyse the potential loss in revenues from declining oil prices. However, some oil producers are more resilient than others taking into account levels of oil production costs and the strength in government finances in the case of National Oil Companies.
Focusing on OPEC countries, the differences in economic wealth and financial strength are quite remarkable amongst member nations. Saudi Arabia, Qatar, Kuwait and UAE are amongst the OPEC countries better equipped to weather the upheaval triggered by low crude oil prices. Saudi Arabia requires crude prices of over $100 in order to balance its budget but the kingdom musters sufficient financial strength and foreign exchange reserves to cope with a long period of low oil prices and low oil revenues. In the United States, shale oil and gas exploration has also been very resilient to low oil prices and the goal posts in terms of break-even points keep shifting to lower levels. The Bakken formation in North Dakota has a break-even average of $40 per barrel but often the break-even point can vary widely even at the same shale formation, for example in the Bakken formation break-even can be as low as $30 and as high as $75 per barrel. However, current low level prices at below $40 are expected to damage considerable number of shale oil enterprises and some decline in the levels of US crude production are expected
for 2016.
Russian oil producers are hurting too but are equally resilient – in fact, Russian crude production has increased throughout 2015 and crude exports are at all-time high – chasing dollar revenues. However, the country is suffering from a combination of shrinking oil revenues and economic sanctions – the economy is estimated to have contracted by 4 to 5% in 2015 and government spending had to
be curtailed.
Looking at the evidence, we can see that low oil prices have not yet significantly curtailed production levels. In fact market share appears to be the driving concern for the leading oil producers. Russian and Middle East oil producers are trying to secure and expand their market share in the Asia-Pacific region. In recent years, Russia has succeeded in striking a number of very attractive oil and gas supply agreements with China. OPEC is also keen to maintain their oil supply market share in the Asia-Pacific region – 60% of Asia crude oil imports comes from OPEC. Recently Saudi Arabia and Kuwait offered substantial crude oil discounts to Asian buyers to spike interest.
Consumer countries are the winners but oil demand is still weak
Consumer countries are benefitting from the current low oil and gas prices. Low energy prices are boosting economies of Western Europe as well as Asian-Pacific economies. Governments in the Asian-Pacific region took the opportunity to cut energy subsidies easing pressure on public finances. Recent estimates by the IMF indicate that governments in developing countries spent an average of $1.9trn on fossil fuel subsidies.
In developed countries the drop in fuel prices are stimulating domestic economies – boosting business and industry and household budgets. IMF estimates that for every $10 fall in oil price, the global economy is expected to grow by 0.2%. The IMF also estimates that the main winners of low oil price environment are the countries struggling with inflation and large oil subsidy bills such as India and Indonesia. China and Japan are large importers of oil and have reaped significantly benefits from low oil prices. A recent study has indicated that for each drop of $1 in oil price, China saves over $2bn annually.
I would like to reiterate my initial statement that pointing out winners and losers is far from being an easy task. Initial optimism regarding the positive impact of lower oil prices on oil demand has been largely misplaced. In fact, disappointing oil demand growth in both Europe and Asia has given us some pause for thought as we realise more complex political, environmental and economic reasons are also affecting the current oil and gas outlook and prospects for the future.
Colin Chapman is the President of Euro Petroleum Consultants [EPC], a technical oil and gas consultancy with offices in Dubai, London, Moscow, Sofia and Kuala Lumpur. EPC also organises leading conferences and training workshops including the 6th Middle East Technology Forum for Refining & Petrochemicals which takes place in Dubai from 14 – 16 February 2016. For further details please visit www.europetro.com
